The SECURE Act Inserted a Tax Time Bomb Into Your Retirement Plan

Mary Read, CPC, CPF, QPA, and Anthony Competelli
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The SECURE Act took effect on January 1, 2020, and it may have significantly undone the plan you had to pass money on to your children.

Many people who have saved significant assets in retirement plans and IRAs were planning to pass this money to their children using Stretch IRA planning. The Stretch IRA is a technique in which a beneficiary can extend required distributions from an inherited IRA over their lifetime. This enables younger beneficiaries to extend the payout period from an inherited IRA over decades, allowing the money to grow tax-deferred and spreading out the tax liability over a long period of time.

The SECURE Act eliminated Stretch IRA planning. Under the new rules, a beneficiary of an inherited IRA or other qualified retirement account must liquidate the account within 10 years with few exceptions.

The SECURE Act has created the need to re-evaluate your plan to pass your qualified retirement savings on to your children, or even on to their children. In addition to worrying about the increased tax liability on your retirement assets, the stock market has been volatile lately, and the interest rate on the 10-year US Treasury Note has hit new lows. Minimizing your tax liability and protecting your assets are both suddenly demanding your attention.

You could continue to let your money grow in your IRA or retirement plan. You will be required to take minimum distributions beginning at age 72. All distributions will be taxable as ordinary income when distributed, whether during your lifetime or upon your death.

With the elimination of Stretch IRA planning, Roth IRA conversions have become a more serious alternative. With a Roth conversion, taxes must be paid on the full value converted at the time of conversion. This can be a burdensome tax bill. At your death, your beneficiary will have 10 years to liquidate the inherited Roth IRA.

An Alternative Strategy

There is another strategy. Under IRS rules, when money is distributed from a qualified retirement plan, every dollar is taxable as ordinary income. The only exception is when a life insurance policy rather than cash is distributed from a qualified retirement plan such as a 401(k) or profit-sharing plan.

Note that life insurance is not allowed in IRAs. Upon distribution, a life insurance policy is taxed at its market value as defined in IRS Revenue Procedure 2005-25. Life insurance is the only asset that is given this unique tax treatment. Purchasing the right policy can generate a lower tax bill.

After being distributed, the policy is owned personally and treated the same as any individually owned life insurance policy. The policy will provide a tax-free death benefit to beneficiaries. Loans can be taken from the policy to provide tax-free income. And, some policies provide tax-free benefits for use during the insured’s lifetime in the event of terminal, chronic, or critical illness or critical injury.

Purchasing the life insurance policy ultimately removes the cost of increasing taxes and puts the money back in the account owner’s control. This strategy also:

  • Reduces the taxes on qualified retirement account distributions
  • Eliminates taxes on future growth
  • Removes the money from required minimum distribution rules
  • Provides peace of mind by reducing market risk

With the elimination of Stretch IRA planning, this strategy provides a tax solution and puts your legacy back on your terms.

Ms. Read is national director of pension and protection planning at Pentegra Retirement Services and partner of M&R Business Development Group. A leading authority in qualified retirement plans with more than 30 years’ experience, she has an extensive background in plan design and development and experience as a marketing executive, financial professional, pension analyst, and pension compliance manager. She is a frequent speaker on qualified plans and contributor to industry publications. And, she is the author of three books.

Mr. Competelli is president and CEO of National Retirement Group and a former BENCOR regional manager. He is a graduate of the State University System of New York at Farmingdale with a degree in finance. He started his own corporation, Financial Reserve Services, in 1990, which he sold to USRP in December 2009. He began working with BENCOR in 2005. He also is a certified tax preparer through AARP, volunteering with local chapters of the Lighthouse of the Blind in preparing tax returns. For more information, contact financialfocus100@gmail.com.

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